The Russian Federation’s growth outlook for 2013 is positive, but remains below the strong growth outturn of 2012, after having lost steam through this year. Following a 3.4-percent GDP growth in 2012, the World Bank revised its 2013 growth projection for the country down to 1.8 percent. The World Bank’s projection for Russia’s growth in 2014 remains moderately positive at 3.1 percent, but with downside risks.

In Russia, economic growth slowed significantly during the first half of 2013:

The slowdown was a result of weaker demand – a result of a combination of external and domestic factors, some of which are cyclical and others structural.

A large part of the cyclical component is related to Russia’s high dependence on oil and gas exports and with it, its exposure to commodity-price volatility.

Structural challenges to the Russian economy and its growth, such as non-competitive sectors and markets, are another important factor. These factors recently moved to the forefront of policy discussions as the economy seems to operate close to its current capacity limit.

Weakness in domestic demand was reflected in subdued investment and consumption activities. Consumption, the main growth driver in the past, expanded at a much slower pace than a year ago. Investment activities fell sharply as large infrastructure projects for the Winter Olympic Games in Sochi and the Northern Stream pipeline neared completion. Business sentiments remained skeptical, which affected investment demand.

External demand remained sluggish. Trade in global markets did not provide the expected relief, while oil prices retreated, stabilizing below $ 100/bbl in the second quarter of 2013. Weak export performance was an important factor for lower growth in the first quarter of 2013.

Recent consumer and business confidence indices point to deteriorating sentiments and lingering uncertainty on how the global economy, and specifically the Russian economy, will play out. While investors have been in a wait-and-see mode for a while, consumers now appear to have joined them and the players in the Russian economy are sitting on the fence.

The economy is close to its current growth potential. Despite the observed broad-based slowdown in the economy, most recent estimates show that the level of capacity utilization remained close to 80 percent in the first half of 2013. That is comparable with rates observed in 2006 and 2007, when the economy was expanding at 8 percent annually. Given the still-tight labor market and the depressed investment activities of the last four quarters, it appears that the economy could be running very close to its maximum capacity.

Weaker growth potential is also reflected in the sector composition of growth. In the first half 2013, growth in key non-tradable sectors, such as construction, financial services, transport and communication slowed dramatically and is not compensating anymore for the gradually deteriorating industrial performance, and the manufacturing of tradables, in particular.

Considering these observations, overcoming structural challenges to the Russian economy and its growth would need to constitute an important aspect of growth-stimulating policies. For Russia, this would constitute a shift from the growth model followed in the past, which focused at stimulating domestic demand. As structural challenges become binding, constraints such as non-competitive sectors and markets would need to be addressed to lift Russia’s growth potential.

Despite the slowdown this year, the Russian economy is projected to accelerate to a 3.1percent growth in 2014. Global recovery could result in an increase in Russian exports starting in the fourth quarter of 2013, while the World Bank projects oil prices to remain stable at about $105/bbl. Next year’s growth prospects will largely depend on the recovery in Russia's most important economic partner, the Euro Area, and the increased investment activities associated with the recently announced large state investment projects to be financed off-budget.

However, this moderately positive outlook is subject to downside risks.Russian exports could remain depressed if the recovery in global demand is further delayed. The tapering of quantitative easing policies, notably in the United States , could temporarily negatively impact Russia's economy through lower oil prices, restricted access to international capital markets, and higher capital outflows. The Bank also notes vulnerability to increasing risks in regard to the quality of the credit portfolio given continuously high credit growth.